Expectation Formation in a Learning and Myopic Environment

Abstract

Expectations play a pivotal role in human life. These are considered as filters through which the whole schematic frame of decision making must pass before implementation. Expectation making is a phenomenon which lacks determinism and objectivity because it is strictly linked with heterogeneous individualistic domains and characteristics of human life. Economic literature often categorizes expectations into rational and adaptive, it also remains concerned with categorizing inflationary expectations of economic agents without focusing much on providing a deterministic frame of reference. The study at hands tries to fill up this literature gap by analyzing expectations subjectively at individual level. The study also offers a deterministic framework of these expectations based on manifold behavioral tendencies possessed by individuals, including optimism, satisfaction, religiosity, economic literacy, shortsightedness and tendency of making comparisons. The study objectively deals with categorizing rational and adaptive nature of expectations on the part of individuals and the underlying factors causing this divide. It also captures differential levels of inflationary expectations and has tried to explain this differential based on various quantitative and qualitative attributes. Finally, the study addresses firms level inflationary expectations and offers its explanation based on some firm level attributes. The study has explored the said objectives through a well-organized field survey by collecting the subjective responses with the help of a structured questionnaire. Within an Ordinal Logit and Generalized Ordinal Logit model design, our study finds that individuals are heterogeneous with respect to rational and adaptive nature of expectations. They are also found heterogeneous in terms of reporting high and low-level forecasts of inflation. On deterministic front, we find that demographic variables including age, income and education significantly affect rationality and levels of inflationary expectations in our first two empirical models. The hypothesized behavioral attributes including myopic tendency, optimism, satisfaction content, economic literacy and relative comparison have also been found significant with respect to their impact on degree of rationality and inflationary expectations. Finally, the proposed firm level attributes including market experience of firm, firm’s size, nature of firm, myopia in price setting, forward looking behavior and information set all are found significant determinants of firm level inflationary expectations.